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Hedge Fund Dominoes

Friday’s insider-trading charges against a hedge-fund titan could be the tip of the iceberg, writes Allan Dodds Frank. Other hedge funds and the McKinsey consulting firm face scrutiny.

Friday’s insider-trading charges against the founder of Galleon could be the tip of the iceberg, writes Allan Dodds Frank. Other hedge funds and the McKinsey consulting firm face scrutiny.

The case brought against the founder of Galleon Management and its technology hedge funds Friday, alleging more than $20 million in illegal profits from insider trading, is more than a shot across the bow of a company named for a ship favored by pirates.

The hedge-fund industry is a big money game that thrives on personal connections, immense compensation, and almost no regulation in any jurisdiction. As SEC enforcement director, Robert Khuzami said of the lead defendant in this case: “He is not a Master of the Universe. Instead, he is a Master of the Rolodex.”

Kumar’s sin is magnified because he comes from the firm famous for its holier-than-thou attitude. McKinsey consultants are imbued with a culture of keeping their clients’ identities and activities confidential.

So this case—which uses wiretaps as if the fund was a Mafia crew—is startling because it could trigger investigations around the world about how Galleon funds made investment decisions and huge gains in China, India, and elsewhere in Asia and Europe. And since Preet Bharara, the newly appointed U.S. attorney in the Southern District of New York, says the investigation is ongoing, it is quite possible that other funds and high-ranking corporate tipsters may be implicated.

This case is even more startling because it alleges that the hedge-fund guys penetrated the heart of the American establishment and corrupted it. If the charges are true, who knows how much of $1 billion or more earned by 52-year-old Raj Rajaratnam, the managing director and founder of Galleon, is tainted?

And if the charges in two criminal complaints are true, Rajaratnam, who initially made his Wall Street name analyzing high-tech investments for a brokerage called Needham & Co., may be the first crook ever caught suborning a senior partner at McKinsey, the consulting firm that claims to have worked for 70 percent of the Fortune 500.

Anil Kumar, the 51-year-old McKinsey director in the spotlight, expressed “shock” at being arrested on conspiracy and securities-fraud charges that could send him to prison for 65 years. Out on a $5 million personal recognizance bond secured by a Santa Clara, California, house he and his wife own, Kumar is a two-decade veteran of McKinsey and is regarded as one of the firm’s leaders in knowledge process outsourcing. That means, among other things, he may tell his clients how to move work offshore or which companies to buy to handle such tasks.

His lawyer, Charles Clayman, tells The Daily Beast: “He was as shocked as everybody that knew him. He is a very decent and very honorable man with a wonderful reputation. Mr. Kumar has faith in the American system of justice, in his lawyers, and that in the end, the truth will prevail, and he will be found not to have been involved in the activity alleged in the complaint.”

In what may turn out to be an understatement if a criminal trial reveals much about the inner workings of McKinsey, Yolande Daeninck, McKinsey’s spokeswoman in North America, said the firm is “very distressed” by Kumar’s arrest. She told The Daily Beast that McKinsey has not yet been contacted by authorities but will co-operate fully with investigators. Kumar, she added, has been “placed on indefinite leave.”

A former McKinsey veteran tells The Daily Beast that to become a director, Kumar must have had dealings with 50 companies or more during his tenure. No doubt, those publicly traded companies will now be wondering what Kumar and his teams might have leaked. I would not be surprised if corporate counsels of McKinsey clients begin re-examining suspicious patterns in trading of their own stocks.

Kumar’s sin is magnified because he comes from the firm famous for its holier-than-thou attitude. McKinsey consultants are imbued with a culture of keeping their clients’ identities and activities confidential. As a result, McKinsey consultants routinely are entrusted with confidential information originating from the absolute top of many companies.

McKinsey’s deep insights into corporations are unparalleled because they are built on trust and the notion that McKinsey’s hotshots are management gurus, rather than dealmakers. They advise on how to run and structure companies and executives trust McKinsey with their secrets.

As a former 20-year-veteran of McKinsey tells The Daily Beast: “The culture is: You do everything to protect the clients and I think people really believe that. That is why you never see a McKinsey consultant quoted.”

Another stunned McKinsey alum tells The Daily Beast: “This is a firm that is totally driven by ethics. They are inculcated from Day One. Marvin Bower (the McKinsey partner viewed as the creator of the modern firm) must be spinning in his grave.”

And even though the case began during the Bush administration, it could be an early hallmark for the Obama administration widening its attack on greed on Wall Street.

McKinsey has 16,000 employees, 400 directors, and offices in 50 countries. In its 85-year history, none of its consultants, until now, have been publicly linked to any sort of white-collar crime. Now the firm will have to prove to its customers that Kumar—if guilty—was operating as a lone wolf.

(One McKinsey consultant—Sandra Boss—had the misfortune of having married the fake Clark Rockefeller and suffering through the kidnapping of her daughter, Snooks, while another former McKinsey star, Jeff Skilling, made his way into ignominy later as the CEO of Enron.)

Today’s McKinsey director in question is no ordinary consultant. Kumar is regarded as a pioneer at McKinsey in their global practice of knowledge-process outsourcing. The wiretaps quoted in the criminal complaint seem to show that the tidbits Kumar fed to Galleon’s captain in the summer of 2008 were not garden-variety stock-market tips. It was more like the quality of information one might get at the top of Goldman Sachs or from a company’s board or from a head of state.

Kumar is charged with leaking information that prompted Galleon in three weeks to buy 5.25 million shares of Advanced Micro Devices, the struggling competitor of Intel, the world’s largest chip maker.

Specifically, on Aug. 15, 2008, Kumar is alleged to have told the Galleon boss on his cellphone: “I think you can now just buy.” Kumar’s information was that Abu Dhabi was going to invest $6 billion to $8 billion in Advanced Micro Devices and that the deal would be announced, perhaps by “the week after Labor Day.”

Kumar later informed Rajaratnam the AMD deal would go down Oct. 7, 2008—the date it actually occurred. Part of the deal was a reorganization of AMD that involved spinning off a significant division and getting some permissions from IBM, another company with a senior executive charged with leaking to Galleon.

The complaint is not specific about any compensation Kumar may have received, except to say that Kumar was a direct and indirect investor in Galleon’s technology funds.

So for the hedge-fund guys accustomed to not justifying the lucrative fees they charge investors—often 2 percent upfront annually, and 20 percent of the gain—there may finally be a day of reckoning.

And even though the case began during the Bush administration, it could be an early hallmark for the Obama administration widening its attack on greed on Wall Street.

And for McKinsey, it will be a troubling time as it seeks to comfort its many clients, since as a McKinsey veteran tells The Daily Beast: “It is the first blemish they have ever had. I am sure there was a lot more confidential stuff going on than what Kumar may have released.”

Allan Dodds Frank is a business investigative correspondent who specializes in white-collar crime. He also is president of the Overseas Press Club of America.